Willie Sutton Bank Vault Company has a debt-to-equity ratio (in market value terms) of 0.75. Its present

Question:

Willie Sutton Bank Vault Company has a debt-to-equity ratio (in market value terms) of 0.75. Its present funds is 15 percent, and it has a marginal tax rate of 40 percent. Willie Sutton Bank Vault is eyeing the automated bank teller business, a field that involves electronics and is considerably different from its own line of business, so the company is looking for a benchmark or proxy company. The Peerless Machine Company, whose stock is publicly traded, produces only automated teller equipment. Peerless has a debt-to-equity ratio (in market value terms) of 0.25, a beta of 1.15, and an effective tax rate of 0.40.
a. If Willie Sutton Bank Vault Company wishes to enter the automated bank teller business, what systematic risk (beta) is involved if it intends to employ the same amount of leverage in the new venture as it presently employs?
b. If the risk-free rate currently is 13 percent and the on the market is 17 percent, what return should the company require for the project if it uses a CAPM approach?
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